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Tech startups hit valuation bumps

00:32

MUMBAI: Indian internet companies are running into valuation speed bumps that threaten to temper their relentless pursuit of growth and bring focus back on company-building — which, investors say, isn't necessarily a bad thing for the sector.

The turmoil in the capital markets will only magnify the concerns around frothy valuation and potentially result in quality investors becoming more picky, venture capital investors cautioned.

From being cheerleaders, VC investors now anticipate the valuations of large internet companies will begin to correct and have begun asking tough questions on key business metrics, slowing bigticket deal-making in the sector.

Investors and entrepreneurs ET spoke with said startups are back to focusing on fundamentals, where trading discount-led growth for profitable unit economics will no longer be an option — according to VC investors, an essential cyclical shift in a maturing startup industry such as India's. Unit economics for an e-commerce company would be the revenue and costs associated with acquiring and retaining an online shopper.

"There is some slowdown in valuation but (that's) not questioning the fundamentals of these businesses," said Vani Kola, partner at Kalaari Capital and an early investor in Snapdeal and Urban Ladder.

"In the next 6-12 months, companies can use this period to gain market leadership and use the cash better than others to create an exceptional momentum," said Kola.

The present depressed sentiment, however, could affect the mindset of entrepreneurs, a situation venture capital investors can leverage to drive down valuations while closing early-stage deals quickly.

"A lot of entrepreneurs who were thinking that let me burn the series-A money on discounting and quickly raise series-B are now going to act smarter," said Anand Lunia, founder of seed-stage VC firm India Quotient.

"They will become more cautious, not negotiate much, take what deals that they can, and sit tighter on their funding, which is good," he added Several Indian entrepreneurs have already raised capital this year to create a longer runway for themselves in an increasingly competitive market. Several venture investors said their portfolio companies have capital to operate for 18-24 months.

Albinder Dhindsa, co-founder and chief executive of on-demand delivery startup Grofers, said his company is not reassessing its budgets yet but "if the market continues to contract for the next 3-6 months, then we will figure out a limited burn and growth rate." Grofers has raised $46 million (about Rs 300 crore) this year.

"Market plunge will shift focus to true company-building," Shailendra Singh, managing director of Sequoia Capital India, said in a post on Twitter. Vijay Shekar Sharma, founder of e-commerce and digital payments firm Paytm, tweeted: "We might be reaching end of cycle where growth at 'any cost' might be giving way to profitable unit economics."

All this is unlikely to stifle availability of capital for early-stage deals, however, as venture capital firms including Accel Partners, SAIF Partners, Lightspeed Venture Partners, Nexus Venture Partners and Kalaari have raised or are raising new funds totaling more than $1.5 billion.

"This is not a downturn," said Zishaan Hayath, who runs Mumbai-based education tech startup Toppr besides being an angel investor in 30 startups. "Investors can't miss out on a good deal now and it's not as if entrepreneurs will run out of capital as they would still be investing in good companies." But Hayath does expect unrealistic valuations to end, with startups becoming more prudent with the capital they have raised. This, however, could put pressure on valuation multiples, said experts.

The past 5-6 months have witnessed several instances where internet companies and investors have disagreed over valuations, forcing companies to raise capital from their existing investors. ET reported last month that Flipkart and Snapdeal faced such valuation mismatches in their recent fundraising campaigns.

Even so, investments above $50 million have increased from two in 2013 and 12 in 2014 to 25 till July this year, according to startup analytics firm Tracxn. Total funding for venture capital-backed tech companies increased to $5.4 billion this year from $4.7 billion in all of 2014.

The abundance of capital has helped build businesses but without enough moats as it allowed companies—from e-tailing firms to food delivery and online classifieds startups—to lure customers with big discounts, masking the difference between real and artificial demand for a service and leading to questionable unit economics. Unit economics in India are worse than in many other global startup hubs, according to experts.

"There are high cash burn rates in China as well, but a single-minded focus on growth (in India) is contributing to uncomfortably high burn rates in certain sectors," said Bejul Somaia, managing director of Lightspeed India Partners Advisors. "This is a function of get-big-fast strategies and challenging unit economics driven by low-order values and high logistics costs."

According to a recent report by Kotak Institutional Equities, gross merchandise value (GMV) per buyer is expected to increase from $140 now to $146 by 2020, as compared to average GMV of $1,092 for Chinese peers such as Alibaba in 2014.

"Sanity has started coming back to the area where it had heated up the most—in large rounds of funding of over $40-50 million, which are much harder to get done now," said Avnish Bajaj, managing director at Matrix Partners India, an early backer of Ola and Quikr.

"Highest quality companies will continue to get money but the rate of increase of valuations will go down and for first time you will start seeing some significant consolidation." Entrepreneurs, too, are realizing that valuations have run up very quickly. "In all these booms what I have seen is that the writing on the wall is clear, but we (delude) ourselves into believing that it's not there," said Yashish Dahiya, founder of Policybazaar who previously worked at global consultancy Bain & Co during the dotcom bubble of 2000.

"My take is that we are getting ahead of ourselves. The change in market is not as rapid as increases in valuation are," said Dahiya, whose company raised Rs 254 crore in April at a valuation of about Rs 1,200 crore.